According to the given forecast compiledwith the help of that model, the consumer prices will grow by 9.8-10.3 per centin 1998. Figure 8 shows that the first six months of 1998 will be moreinflationary. For example, according to the first scenario, the increment ofthe consumer prices for the first half year will constitute 8 per cent, andaccording to the second scenario--7.6 per cent.

Figure 10

Figure 11

2.2 State Securitiesmarket

Nominal volume of the state internal debtaccumulated in the GKOs-OFZs increased by about 52 per cent over 1997. The parvalue of the outstanding state bonds on the internal market constituted bymid-December Rb 346.55 trillion or 13.9per cent of GDP. For the sameperiod, the stock of GKOs and OFZs placement amounted to Rb 438.4 trillionworth. The sale of the state bonds allowed to raise Rb 378.2trillion.

During practically the whole year, right upto the autumn, there was a steady decline in the GKOs-OFZs yield. Consequently,the cost of the state debt service nominated in roubles has declined (Fig.12).

In March 1997 the second issue of the RussianEurobonds in the volume of DM2 bln worth with a seven-year maturity at 9 percent interest rate (the first issue of eurobonds to the tune of US$1 bn worthwith a five-year maturity and 9.25 per cent yield took place in Novemberlast year). At the end of June, the government of Russia launched eurobondswith a ten-year maturity to the total of US$2 bn worth. The volume ofsubscribers outnumbers twofold the volume of the offer. Limit on the emissionwas dictated by the limitations imposed on the external borrowing for thecurrent year. Yields on the new tranche of eurobonds somewhat increasedreaching 10.5 per cent annual. However, taking into consideration an increasein duration period and the emission volume such an increase is consideredinsignificant. In October 1997, the government of Russia additionally placedUS$400 mn in the third tranche. All that testified about the growing interestwhich foreign investors showed toward the Russian financial markets and alsoplaced trust in the governmental economic policy before the financial crisis.However, changes in political outlook linked with the summer privatisationauctions and the autumn scandals which took place in the higher echelons ofpower have resulted in the crisis of trustworthiness in the government policy.These events coincided with the financial crisis which most negativelyreflected on bond yields.

Figure 12

In the first half of 1997, investors interesttoward the municipal and regional bonds have substantially increased due to thegeneral decline in GKOs-OFZs yields. In the first-quarter, those securities didnot belong to high yielding instruments. Moreover, in June MICEX started totrade in "agrarian" bonds with 1, 2 and 3 year maturity. These bondsrepresented debt restructuring of the subjects of the RF to the government ofRussia accumulated for the commodities credits granted by the Ministry ofFinance in 1996. Overall volume of that debt amounts to Rb 9.1 trillion oldroubles.

Stabilisation of the internal debt dynamicshas permitted the Ministry of Finance of the RF to implement consistently oneof the main objectives of managing the debt, i.e. maximum prolongation of theduration periods for the state bonds. By the end of 1997, average durationperiod of GKOs-OFZs constituted about 280 days, while at the beginning of1996--105 days. Issuance of the new series of the OFZs and, in particular, withfixed coupon as well as rescheduling on 15 March 1997 of the Ministry ofFinance's debt to the Central Bank into 13 new OFZs tranches with duration termbetween 4 and 8 years have contributed to longer maturity periods. Prolongationof the duration periods for bonds diminishes the risk profile of increasingcosts for the state debt service, allowing the government to anticipate betterthe corresponding expenditure in budget drafts and decrease the increment ratesfor the issuance of the new GKOs-OFZs (Fig.13)5

Figure 13

Besides the increased duration of thegovernment bonds, the lack of significant difference between the yields onshort-term papers and long-term papers testified about a high degree of trustin the monetary policy pursued by the Government and the Central Bank ofRussia.

Crisis on the world financial marketstogether with the worsened political situation in Russia have resulted in thetrend change on the GKOs-OFZs market. From November 1997, there was a steadygrowth of the state debt service (Fig. 12). Nevertheless, the yield growth hasbrought about an increase in the transactions volume on the market. It seemsthat many investors considered the yield rate of 32-35 per cent annual assufficient one for the near future.

Figure 14

Yield increase on the state bonds in theinternal market have resulted in a decline of quotations on the Russianeurobonds. At the same time, quotation for all other Russian bonds (forexample, debt to the London club, VEB bonds) have dropped. This,understandably, decreases possibility for effective government borrowing on theexternal market in the near future.

Nevertheless, the temporary structure ofyields on internal papers demonstrates that in the given market with a highdegree of probability, there will be relative normalisation of the situation.Lack of significant differences between yields on the sort-term state bonds (afew days) and the long-term ones (about one year) can be understood asexpectations for further reduction in inflation and the interest rates in themarket by mid-1998 (Fig. 14).

Growth of the yields rate in the statesecurities market in November-December 1997 led to an increase in the share ofGKOs-OFZs in the structure of the majority of the investment portfolios.However, the scale of this process is being weakened by a general decline incapital inflow in the Russian financial markets from foreigninvestors.

In case the government does not substantiallyincrease the volumes of borrowing, then due to an increase in debt service in1998, there will appear favourable conditions for the development of thecorporate equity market. Nevertheless, in Russia at present, there are nosecurities backed by real assets of large corporations which little depend onthe volume of currency reserves and the policy of the Central Bank.

2.3. Interbank Credits Market

In 1997 decline in the inflation rates,yield fluctuations on the state bonds and the level of liquidity for the wholebanking system determined the dynamics of the credit rates in the interbankrouble market (Fig. 15).

Figure 15

In January-April 1997 the interbank roublemarket demonstrated significant fluctuations in the credit rates with differentmaturity. Average rate level for the given period constituted 25-30 per centannual. From May, following the decline in the yields rate in the statesecurities market (Fig. 12), average credits interest declined to 15-20 percent annual.

The crisis of the financial markets has ledto considerable adjustments in the interbank credits market. The interest rateon the prevailing one-day credits rose from 12 per cent-17 per cent annual upto 30 per cent annual by the beginning of December. Among reasons for suchdramatic interest rates increase, one should identify the effect of the"put-off crisis" on the GKO-OFZ market and the decline in the level of mutualtrust in relations between the commercial banks. The latter have sufferedconsiderable losses as a result of devaluation of a large part of their assetsrepresented by the state bonds and corporate equity.

Despite the December increase in the interestrates and the closure of the credit limits by a number of large banks, it isimportant to note that there was no banking crisis in 1997. The market turnoverwas gradually growing and reached in March-November the volume of RB 13-15roubles worth per week (Fig. 16) which was considerably larger (inconstant prices) that the turnover of the interbank credit market before theinterbank crisis of 1995 as well as the turnover of the secondary GKOs-OFZsmarket by the end of 1997 (Table 3). On the whole, the annual volume of thegranted interbank one-day credits surpassed Rb 700 trillion. Their share in1997 constituted 60-65 per cent of the overall volume of markettransactions.

Implementation by the Central Bank of Russiaof the mechanism for transactions REPO and widening of the possibilities forgranting custody credits against securities have produced a stabilising effecton the interbank rouble credits market. However, so far ode-day credits areprevailing in the market. It is connected, to a considerable extent, with theshaken financial stability by the end of the year of a number of largecommercial banks and the closure of the limit for mutual crediting.

Figure 16

2.4. Currency Policy

In the first quarter of 1997, the officialand market dollar exchange rate grew steadily by about the same pace 0.6 percent-0.7 per cent per month (or 7 per cent-8 per cent annualised). At thebeginning of the second quarter, the market quotations started to lag behindthe official ones. In April, the dollar posted 0.3 per cent up on MICEX (3.6per cent annual), and on the interbank over-the-counter market fell by 0.4 percent. In May-June, the growth of the official rate practically stopped.However, in July the dollar rate was growing by a high pace. Overall incrementin the official and the market dollar exchange rate in the first half-yearconstituted correspondingly 4 per cent and 3 per cent. In the second half-yearthe dollar growth rates declined. On the whole, over the second half-year boththe official and the market dollar rate grew by about 3 per cent (Fig.17).

Figure 17

During the first eight months of 1997,movement trough time of the dollar rate was connected not only with seasonalgrowth of the export earnings but with the favourable marcoeconomic situation.In the circumstances of an increased capital inflow, the Central Bank wasforced to support the dollar rate maintaining the targets enshrined in themonetary programme.

However, beginning with mid-autumn of 1997,the situation has been changing dramatically. Destabilisation of the politicalsituation in Russia together with the international financial crisis havecaused a massive capital outflow effected by the non-residents from thefinancial markets. Repatriation of the profit obtained from the statesecurities market has determined the increase of demand for dollars. In thesecircumstances, the priority of the Central Bank consisted in the preservationof the rouble exchange rate. Any sharp changes in the rouble rate, could haveled to the Mexican variant of the course of events, when devaluation of thenational currency dramatically strengthened the wish of the non-residents toconvert their financial assets into hard currency. In those circumstances, on10 November 1997 the Central Bank of Russia announced targeted parameters ofthe currency policy for the years 1998-2000 (See above). Those parametersdefined its stability and continuity and at the same time gave large freedom ofmovement for the implementation of the currency policy, in particular, withrespect to widening of the currency corridor. The pace of growth of thecurrency rate as before will be looked at as the main indicator influencingboth the inflation rate and the conditions for attracting investments andeconomic recovery.

2.5. Stock Market

One can single out several periods in dynamicof the Russian stock market in 1997. First - from January till the beginningof March - was characterised of the market surge which attracted significantcapital stock of foreign and domestic investors. It resulted in the quotationgrowth for the majority of shares (IET stock market price index6

grew by 24 January by 52.9 per cent) and asharp increase in the volumes of transactions (Fig 18). Average yield of themarket by 20 February amounted (sales results on RTS-1) to 25 per cent permonth. However, in the last decade of the month, the stock market index startedto decline (technical "price adjustment" after a month and a half of anuninterrupted growth).